Economic Policy in the Rough: A European Journey€¦ · Wallace “unpleasant arithmetics” on its head. 4. A certain amount of risk sharing is needed in EMU: either via national

Economic Policy in the Rough:

A European Journey

PIIE

12th November 2019

Marco Buti, Director General ECFIN, European Commission

1

Five Pivotal Moments: better known or forgotten

2

G20 TorontoDeauville

meeting (France-Germany)

Latvia asks for financial assistance

Draghi’s speech at Jackson Hole

November2008

January 2010

October 2010

June 2010

August2014

July 2015

Full extent of fiscal problem is recognized

“Grexit” Debate

Greece

August2018

Greece exits programme

The Baltics: a prequel of the crisis?

Key aspects

• “Baltic Tigers”: strong performance in mid 2000s, fuelled by credit expansion

• Crisis mainly caused by imbalances, resulting in capital flow reversals

• Differing policy responses across Baltic countries different trajectories

3

GDP growth

-15,0

-10,0

-5,0

0,0

5,0

10,0

-3,0

-2,0

-1,0

0,0

1,0

2,0

3,0

2006 2007 2008 2009 2010 2011 2012

%

Euro area Latvia (rhs)

11/08: Latvia applies

for programme

05/10: Agreement on

EFSF09/12: OMT

01/12: Latvia’s

programme expires

Source: Eurostat

Latvia and the other Baltics: a prequel of the crisis?

Lessons:

1. Financial crises even in small countries can have pervasive effects and a high potential for contagion.

2. Sustained capital inflows embellish the fiscal accounts. Bad fiscal accounts are often the effect, not the cause of a crisis.

3. Baltics story could have been used to inform programmes for struggling EA countries and prioritising EA actions (BU).

4. The exchange rate regime is more than a monetary arrangement.

5. Not nominal adjustment, but deep structural reforms are key for sustained growth and stability.

4

Deauville - October 2010

5

Key aspects

• Franco-German compromise between Sarkozy and Merkel catered to domestic audiences

• FR accepted tighter SGP and “bail-in” of creditors, Germany accepted future ESM

• No prior consultation of EA partners, US, financial markets or ECB

• Agreement was negatively perceived by markets and heightened contagion risk

0

5

10

15

20

25

30

35

pps

Italy France Ireland Greece Spain

Source: Bloomberg

Euro area 10 years treasury bonds, spreads to the German bunds

Deauville OMT Grexit

debate

&

ECB

PSPP,

CBPP3

ECB CSPP

Deauville - October 2010

Lessons:

1. Financial markets operate according to horizontal and vertical lines: no gradual pressure on borrowers.

2. Risk reduction measures, if they are not coupled with risk-sharing measures, can actually increase risk.

3. EU level decisions should be insulated from domestic political economy considerations.

4. Processing everything through the “moral hazard lenses” does not lead to sound policies.

5. Not coordinating with partners like ECB can be very dangerous.

6

If you’re going to restructure Greece, … you have [to have] the ability to in effect

protect or guarantee the rest of Europe from the ensuing contagion.

Timothy Geithner on Deauville “

G20 Toronto summit - June 2010

7

Source: Eurostat, IMF WEO April 2019

Key aspects

• Backdrop: unprecedented scale of both monetary and fiscal packages agreed at previous G20 summits

• Commitment to at least halving deficits by 2013 and stabilizing debt-to-GDP ratios, supported by structural reforms

• Deficit countries should boost savings; surplus countries should reduce reliance on external demand

• Commitment to reform the financial regulatory framework & unwinding protectionist measures

There is a risk that synchronised fiscal adjustment... could adversely impact the recovery. There is also a risk that the failure to implement consolidation...would undermine confidence and hamper growth”

G20 Toronto Declaration

“

-14

-12

-10

-8

-6

-4

-2

0

2

(% O

F G

DP

)

Japan United States G20 (mean) European Union

General government balance

G20

Toronto

2013

deadline

G20

London

G20 Toronto summit - June 2010

Lessons:

1. Lost the « spirit of London »

2. In aftermath of crises, early withdrawal of fiscal support can be damaging. We didn’t see the increasing constraints on monetary policy.

3. Need to better weigh risks and costs in the trade off between sustainability and stabilisation.

4. Choosing the composition of fiscal support matters: not all measures are alike in their effects.

5. Stand-still on trade protection to continue, but protectionism started to creep in.

8

Greece: a fiscal and a structural crisis

9

Main Events

• Revision of fiscal data in 2010: budget deficit for 2009 revised to 15.4% of GDP from 3.6% of GDP initially projected in April 2009 EDP notification

• GLF (2010, €52.9bn); EFSF (2012, €141.8bn); ESM (2015, €61.9bn)

• “Grexit” speculation in July 2015

• Third ESM programme successfully concluded in August 2018

• ESM estimates budgetary savingsfrom its programmes at over 6.5% of GDP. Implicit interest rate lowerthan in Spain, Italy, Portugal since2012

Deficit and GDP growth in Greece1

Programmes extended beyond austerity: key structural reforms to enhance competitiveness

and growth, e.g. in labour market, the pension system, healthcare, public and tax administration

and the financial sector.

1st Programme:(bilateral loans via GLF, IMF)

3rd Programme(ESM)

2nd Programme(EFSF & PSI agreement)

1 Source: Eurostat, ECFINprogramme substituted with new programme programme extended

-20

-16

-12

-8

-4

0

4

0

20

40

60

80

100

120

140

160

180

200 Genera

l govern

ment b

ala

nce (%

of

GD

P)

Public d

ebt

(% o

f G

DP)

Public debt Public debt - 2010 revision

General government balance Balance as estimated in April 2009

Greece: a fiscal and a structural crisis

10

Lessons:

1. Greece’s fiscal crisis affected the narrative on other countries and on EA predicaments.

2. Crisis within EA is (also) of structural nature: “classic” IMF programme unlikely to succeed.

3. Debt sustainability needs to be addressed in timely but sui generis manner: politics and perceptions to be reckoned with.

4. The EU’s commitment to the single currency project should not be underestimated, but operating under “ultima ratio” can cause costly delays for distressed countries and creditors.

5. Importance of democratic accountability, communication and domestic ownership. Commission cannot act as ” agent of creditors ”.

0

500

1000

1500

2000

2500

3000

3500

4000

4500

5000

0

0,5

1

1,5

2

2,5

3

3,5

4

4,5

5

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

2019

in b

il. E

UR

%

Policy Rate Eurosystem Total Assets

Draghi at Jackson Hole - August 2014

Key aspects

• Backdrop: fragile recovery; largely exhausted conventional monetary policy; increasing deflationary risks

• Speech was followed by unprecedented monetary policy (TLTRO, ABSPP, CBPP3), but not by fiscal expansion or meaningful structural reforms

Draghi warned against:

• Risk of hysteresis effects in unemployment

• Being too cautious with monetary and underusing fiscal policy

• Too little long-term economic cohesion in EA

11

Jackson

Hole

“whatever

it takes”

Lehman

Brothers

Overburdened Central Bank

Draghi at Jackson Hole - August 2014

Lessons:

1. Monetary policy cannot be left alone: more balanced policy mix required.

2. Achieving a EA fiscal stance via horizontal coordination of national policies is very difficult.

3. Excessive fiscal prudence is also a form of fiscal dominance: Sargent and Wallace “unpleasant arithmetics” on its head.

4. A certain amount of risk sharing is needed in EMU: either via national budgets or via ECB balance sheet.

12

I do not blame Mr Ickes for being cautious and careful. But the risks of less speed must be weighed against those of more haste. He must get across the crevasses before it is dark.

J.M. Keynes, letter to F.D. Roosevelt “1933

The risks of ‘doing too little’ […] outweigh those of ‘doing too much’M. Draghi speech in Jackson Hole“2014

Key lessons for future work on EMU

13

Need to address risks of financial crisis and contagion channels

Achieving EU fiscal stance via national coordination only is

very difficult

Banking union

Geopoliticalrelevance of

EMU

Democratic

accountability

Fiscal stabilisation

capacity

Balticcrisis

Deauville

JacksonHole

Greece

Risk reduction requires risk

sharing

Inter-governmental setting increases the risk of “ultima

ratio”

Crisis resolution should also rely on community method

Need to rebuild trust between MS

G20Toronto

International role of the euro should be developed

Policy choices to address both ST and LT challenges

14

Adequate ST/LT policy mix

Structural reforms:

• Feasible

• Forward-looking

• Fair

Monetary policy:

• Patient

• Persistent

• Prudent

Fiscal policy:

• Timely

• Targeted

• Temporary?

« Right here, right now »

Marco Buti

European Commission, DG ECFIN